Gains from Australian Dollar Weakness Overstated

Consumers and business may need to change how they behave if the weaker Australian dollar is to be beneficial. Otherwise, Australian investors could be suffering until it starts rising again.

Manufacturers have been calling for a lower currency to help boost their competitiveness against imports and to help penetrate international markets. Retailers were losing out to overseas e-traders. Labour unions and employers were in agreement about the imminent dangers of a strong currency on employment. Miners were losing the anticipated currency offset to falling international commodity prices. The Commonwealth Treasurer had flogged the strong currency for its effect on his revenue targets as he went about explaining his budget strategy this month.

The strong dollar, it appeared, had no friends. People's taxes would be higher because of it. Our schools would be under funded. European austerity loomed. On Sunday, the minister for trade described, without any qualification, a weaker dollar as "a good thing".

Among the questions going begging in the current discussion is whether, as a group, Australians are better off with an indefinitely falling currency or whether there is an optimal level at which the dollar should settle. If the latter, why will it stop falling at that point and not be carried forward by the momentum of the market?

Shifting firmly into the 'lower dollar is better' camp risks forgetting the nature of the trade-off.

All 22 million Australian residents benefit from a stronger currency because they have to buy goods (or have them bought for them). A stronger dollar permits greater freedom to travel. A weaker currency almost certainly reduces the living standard of anyone who has to buy goods or services.

A stronger currency permits lower interest rates and eases debt servicing for those with loans or aspiring to buy a house.

Australian corporates, financial institutions and governments will find it easier to fund private and public capital works if the currency is stronger. That allows better productivity outcomes.

A stronger currency will make overseas expansion easier for Australian companies, permitting a break from a relatively small domestic market to pursue growth opportunities that would not otherwise exist.

A weaker US dollar - the flip side of a stronger Australian dollar - will boost US dollar denominated commodity prices. Any earnings boost Australian miners might get from a drop in the local currency can be offset, if not washed away entirely, by lower prices on commodity exchanges in London and New York as the US dollar rises.

Whether these benefits from a stronger local currency offset the impact on the profitability of local companies (and their consequent investment and employment decisions) is a question for a finely tuned econometric model. An election is not going to decide which is better although a commitment to produce a study of the costs and benefits may be a worthwhile election promise for a party interested in keeping the debate on track.

Ironically, as if to drive home the point, Ford Australia decided to close its local manufacturing operation just as the dollar was beginning to fall. Ford turns out to be a good example of the trade-off. As the company's chief executive said last week, there did not appear to be any foreseeable level of the currency capable of solving Ford's problems.

At the heart of the problems facing Australia's car manufacturers, including Ford, is the Australian motorists' dislike of the local product. Familiarity, it seems, breeds contempt. Australia's car manufacturers were losing share while the dollar was weakening as well as while it was rising.

Ford was in a vulnerable position because it lacked an export strategy to create scale. Holden and Toyota have more globally integrated businesses which have helped save them from the same fate. Their experiences suggest strategy is more important than currency. With a sound strategy, the currency might help at the margin. Without the strategy, the currency is irrelevant.

A weaker dollar will only be beneficial (perhaps) if Australian consumers are prepared to buy local products. As long as Australians are unenthusiastic about local products, the higher the currency the better. Consumers pursuing a penchant for overseas goods in the face of a weaker Australian dollar have the potential to create a genuine economic crisis.

Even if there is some respite for manufacturers in the next few months, no-one should count on the currency getting to a comfortable level and staying there for any length of time. There are simply too many variables at work globally for this to be a realistic basis for planning. In a world of currency volatility, competitive advantages will be based on innovation, skills, location or speed of adaptability.

The trade-off needs to take account of wealth effects, also. With compulsory superannuation, the wellbeing of retirees as well as the savings of the working age population and its families depend increasingly on the buoyancy of Australia's capital markets.

In theory, a lower currency should boost the profitability of Australian companies exporting, competing against imports or operating profitably overseas. To that extent and everything else being unchanged, the equity market should pay more for those companies. The wealth effect should be positive.

Unfortunately, this assumes Australia is on a planet of its own. Australian equity prices will continue to be set in a global context. The flow of funds based on asset allocations around the world will set the tone for the market. One of the considerations among international investors will be what is going to happen to the currency. The Australian market is unattractive as long as the currency is falling even if Australian dollar profits are being supported. Indeed, further currency weakness can be caused by international asset allocators pulling funds from the Australian market.

Foreign investors pile into Japanese equities when the yen falls because they understand that Japan's export oriented industries are leveraged to the currency move through higher volumes not just through price effects. The same cannot be said of Australia's listed companies. With very few exceptions, companies outside mining tend to have a domestic focus. The miners are generally unable to boost sales to take advantage of a weaker currency. Indeed, the currency tends to be weak because sales are flagging.

Overseas investors will lack enthusiasm for listed companies as long as the currency is falling if Australian companies cannot take advantage of the currency change to expand their markets.

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